Whitestone REIT (WSR) Q4 2012 Earnings Report, Transcript and Summary

Good day and welcome to the Whitestone REIT Fourth Quarter 2012 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Juanita Baker, Head of Investor Relations at Whitestone REIT. You may now begin.

Thank you, operator. Good afternoon, and thank you, all, for joining the Whitestone REIT Fourth Quarter 2012 Earnings Conference Call. Joining me on today's call will be Jim Mastandrea, our Chairman and CEO; and Dave Holeman, our Chief Financial Officer. Please note that some statements made during this call are not historical and may be deemed forward-looking statements. Actual results may differ materially from those indicated by the forward-looking statements due to a variety of risks and uncertainties. Please refer to the company's filings with the Securities and Exchange Commission, including the company's Form 10-K and Form 10-Q for a detailed discussion of these risks. Acknowledging the fact that this call may be webcast for a period of time, it's also important to note that today's call includes time-sensitive information that may be accurate only as of today's date, March 12, 2013. The company's earnings press release and fourth quarter supplemental operating and financial data package have been filed with the SEC, and the Form 10-K will be filed tomorrow. The filings are or will be on our website, whitestonereit.com, in the Investor Relations section. Also, included in the supplemental data package are reconciliations from GAAP financial measures to non-GAAP financial measures. And with that, let me pass the call to Jim Mastandrea.

Thank you, Juanita, and thank you, all, for joining us today on our call. Today, we're going to review our fourth quarter and annual operating results and update you on the recent progress of our initiatives. Today's portion of our call will focus on our financial results and the overall strong financial condition of Whitestone. As we have stated on our previous calls, this year has been about creating value in our Community Center operating portfolio through lease-up, redevelopment and repositioning, in addition to the select acquisition of accretive value-add properties. Now let me review our progress in 2012 and highlight some of our accomplishments. We strengthened our balance sheet and capital base by financially engineering our capital structure to assure the lowest cost of capital with relatively modest leverage and a broad diversification of tenants. We strive to maintain our financial flexibility to protect against unforeseen economic climate changes. Having survived numerous real estate downturns since the 1980s and most recently the recession of 2007 to 2009, I've learned that leading through these cycles provides the reward of upside opportunities to capitalize upon when others may find themselves financially constrained and gives us a competitive advantage when making acquisitions and then attracting new tenants. We grew our asset base to over $400 million in 2012, with the acquisition of 5 Community Centers totaling $107.6 million, each located in the Phoenix marketplace, where we now own 13 Community Centers and approximately 1.3 million square feet of gross-leased square area, plus 2 development sites. Our Phoenix properties were acquired in single off-market purchases since late 2010 from property owners, banks and special services. And we closed at a pace that has earned us high marks for a certain day of closing, doing what we say we were going to do. We…

Thank you, Jim. I will start by reviewing our balance sheet or financial position, then turn to a review of our key operating results, and conclude with a few comments regarding our outlook. During the quarter, we continued to strengthen our balance sheet by growing our real estate assets by $20 million or 5% from the third quarter and $117 million or 40% from 1 year ago. We strengthened the balance sheet by lowering our weighted average interest cost as of the quarter end to 4.7%, as compared to 5.4% a year ago; by continuing to grow our total market capitalization to $432 million as of year end, which is up from $392 million at the end of the third quarter and $275 million as of December 31, 2011; by increasing our pool of unencumbered properties, that is, properties without secured mortgage financing, to 24, the cost basis of our pool of unencumbered assets now exceeds $200 million which represents approximately 1/2 of the cost basis of our total assets; and by improving our unsecured credit facility. Subsequent to year end, we amended our current unsecured credit facility, increasing the borrowing capacity by $50 million to $175 million. We added an accordion feature that will allow the facility to further increase to $225 million. We reduced the interest rate by approximately 1%, which translates to $700,000 or $0.04 per share on the balance currently drawn. We extended the term of the credit facility by 2 years to 2017, and we eased the overall financial covenants including the lowering of the capitalization rate to value assets. The new credit agreement provides us the ability to execute contracts and quickly close on value-add acquisitions as we continue to accelerate our growth. We believe the increased facility reducing -- reduced pricing and expanded…

Thank you, Dave. Before we close the prepared remarks, I would like to comment on where we think we can improve, and give you a brief look to the future. The key area we can improve is to capture the cash flow from the intrinsic value we have embedded in our real estate as quickly as possible. We buy Community Center Properties off-market and at the right price. These Centers have ranged from 20% occupancy to 95% occupancy, in some cases, 100% occupancy. When we make an acquisition, we look for cash-on-cash returns in excess of 70% on an unleveraged basis, including the vacant portion of the real estate, as well as the land that we acquire along with the asset itself. When we increase the occupancy to a stabilized 93% to 95%, we expect double-digit returns on our initial investment. The cost of the land and out parcels are built into that purchase price. When we build on or develop land and/or the out parcels, we look to achieve returns in the high teens, mid-20s. Any tailwind from the economy and/or inflation we just count as a bonus. We look for the double-digit returns short of any of that help. We continue to build on our strength and we have adjusted our course, making some timing and people changes as we work towards our goals and objectives. As I look to the future, our core strength is our people. We select and retain only those who have demonstrated a passion, and I mean, a passion, and a desire to continue to hone their skills for the real estate business within the Whitestone culture. We train, educate and provide the necessary tools for our associates to be successful. Specifically, our in-house training and the development of our people allows us…

[Operator Instructions] And we'll go first to Paul Adornato with BMO Capital Markets.

If we look at the expiration schedule for 2013, it looks pretty heavy in terms of the percentage of base rents that are expiring. So I was wondering if you could talk a little bit about the activity that you've had to-date and what the outlook is for the rest of the year. And also, are there any large spaces in there that might affect the numbers one way or the other?

Paul, this is Dave. I'll start out and Jim may jump in as well. So if you look at our lease expirations, typically, we have signed shorter leases, 3 to 5 years. So typically, we see 10% to 20% of our portfolio roll each year. We're very comfortable with that. During the last couple of years, our renewal rate has remained consistent in the mid-70s, I believe about 75%. We also do not have any big spaces rolling in '13. Our largest tenant is 1.2% of our revenues. So really from a big space or big tenant perspective, we, as a company, we don't have any of those. We see a -- our pipeline of leasing, right now, is robust. As you know the timing of tenant leases doesn't always match up with the timing of financial quarters. But we had a lot of activity, specifically even in the Phoenix region, that we see in our pipeline of leasing and leasing activity.

Yes, Paul, I'd like to add to that. A couple of things we've done, we've added 2 additional leasing people to our Houston operation and we expect to add 1 or 2 to our Phoenix operation. We've also have shifted almost entirely to a total compensation pay-per-performance program, and we used to have our leasing people on a base salary. And then on top of that, we would pay a commission and then some bonuses and some stock. What we've done is we've shifted to a draw, a draw system. So it starts with a draw, we add to that commission and then we add to that bonuses and then we add to that stocks. So it's a program that makes our folks really earn their base as well as any of the upside. And it's more rewarding than the initial program that we had. But we think that it really puts everybody in line with what we're doing. And it also focuses on -- the percentages adjust themselves for space that has to be released versus space that's new space. Now, one of the things I touched on in my formal remarks is we have gone to an iPad system. That iPad system, and I'll give you the short version of it, each of our property managers now carries an iPad, and they go around and they meet each tenant each month. So normally, we would send out a rent invoice around the 15th to get payment right around the fifth of the following month. They now approach each tenant and they ask them 4 basic questions, along the lines of, does the space work for them, whether their co-tenants would help their business, things like that. But they actually talk to them each month, and they -- while…

One other thing I just like to add, real quickly, is that if you look at the near-term roll, in a few of our Centers, we have executive suites where you have really smaller-spaced tenants that tend to be 1-year leases. So you'll always see a larger amount of tenants in that first year just due to the -- some of the executive suite tenants who roll annually.

Okay. I appreciate the detail there. If we were to look at comparable space rent spreads, are we still burning off prerecession leases? Or I guess another way to ask the question is, when do you expect rent spreads to turn positive in general?

I think if you -- if you look at the markets we operate in, obviously, you start with the Phoenix market, that had a more significant downturn than the Houston market. We really are seeing lots of great signs in Phoenix, of recovery. You're seeing housing inventories at low levels. So we really think that we'll see a quicker upturn in the Phoenix market. If you look at our Houston properties, Houston has performed fairly well through the downcycle, and just had not nearly the big impact that was in the Phoenix market. The spreads, I think for the most recent quarter for comparable leases were up 3.3% on a straight-line basis and up 2% on a 12-month roll. We expect for that trend to continue. I think if you look at the properties we bought in Phoenix, we bought properties under stress that most of the leases have been reset. So when we reset at the lower levels, so we believe as the economy continues to come back, we'll be able to increase those rents.

Let me add to that, Dave. Paul, one of the things that we do is that we put money into our properties right after we buy it. And we're beginning to go back into Texas, and some of our properties that we're recycling, we're putting money into these properties. If we watch closely and then track it, and we'll try to do this in one of our future calls, is to show the effect of that to -- once we invest the money and say it's $25,000 or $100,000 in a property, for example, we're looking at 1 property now to invest $60,000 and it's just in some changing, some patios and, things like that. Usually, when you do something to a property, you then have the opportunity to go back and ask for $0.05, $0.10 or $0.25 more per square foot. And often some of that, too, is translated into common area maintenance. So we like to do something for our tenants first, and then we usually follow-up and we'll look at rents when the leases roll over, because we've now captured them on our property.

And we'll go next to Carol Kemple with Hilliard Lyons.

I think on the third quarter call, you all talked about possibly doing some dispositions, maybe some of your properties in Houston. Where are you at on that? And is there anything on the market right now?

We talked on our third quarter call that we had identified 11 properties to dispose of over the next -- over a couple of years. I think we said that we had 3 of those properties targeted to be marketed in the fourth quarter. We have done that and that we are -- they're listed with brokers. There's no urgency on our part to sell, so we want to sell those for the right price. So we currently have 3 smaller properties in our -- they were legacy assets. After -- when we joined the company, they are listed for sale, and we still continue to do that. It's about $30 million to $40 million in assets. Not a large amount of assets, but there's $30 million to $40 million in assets that we think we could use the money by recycling that capital, use the money for better, better items.

Yes, normally, Carol, we would not press release or 8-K when we list them, but when we sell them, we'll definitely do that.

What kind of feedback are you getting on the potential tenant, potential buyers about the properties? Or I guess, who are your potential buyers? Are they mom-and-pops, or pension funds, or who's looking at those?

That's a good question. They're usually small, ethnic families. Like small might be 3 or 4 like family members coming together to buy it. It helps the children and the business. I think we mentioned we have these 1 property that's a legacy property, it's like 26 townhomes. I want to say that there's now -- it's either 19 or 26, it's in that low number. It was converted to office buildings and for whatever reasons, it was in the portfolio. We have an ethnic family that is looking at that because it's a small-enough size. They think they could buy it and manage it themselves. Those units were originally built as residential. They're now being office-leased and they're thinking about converting them. So usually it's smaller investors, and we don't have a lot of those properties but we have a few. And in all of them, the book value on them is under $100 per square foot.

Okay. And then I know you mentioned earlier in the call, you would like your FFO to exceed your dividend payout this year. At this point, are you still comfortable with the current dividend payout?

Yes. We -- one of our key initiatives, and it's been a key initiative for a while, is ensuring that we continue to drive our FFO. I think on the call, we pointed out probably 4 key areas this year for driving FFO. We're going to do the $40 million to $50 million in acquisitions in the near-term using low-cost debt, which will significantly contribute to FFO. We've got the lease-up embedded value in our properties that will contribute to FFO. You've got the renewal of our debt at significantly lower interest rates that will contribute to FFO. And then I just went blank on the fourth one...

The intrinsic value.

The intrinsic value in lease-up of the portfolio. So we, as management, Carol, feel there's absolutely significant value that's going to come through on the operating statement as a result of the hard work of the Whitestone folks. And because of that, we think we're very confident in our ability to get FFO in excess of the dividend this year. From a corporate governance standpoint, our Board clearly evaluates our dividend level each quarter and declares a dividend and they do look at lots of factors. They obviously look at all those ways we add value and ensure that we are producing the results that we need to.

Carol, just to give you an idea, that the numbers that we reported are based on the existing in-place real estate that is rented and generating cash. We have, in addition to that, approximately 600,000 square feet of space, that is either shell to fully completed space, so the cost to complete it and lease it is not that significant. We have 6 pads, we have 2 small development parcels we're going to start this year, we have 1 larger development parcel. If we took all of that property and we put the cost to it to get it to a 93% to 95% lease over the next 2.5 years, that would add an excess of $0.50 per share in terms of what we call intrinsic value. It's already there, we own it, all we have to do is extract it. Now we don't see ourselves being able to pull that out in a year. But we know what we have and it's manageable. And we're pretty excited about that. And that's why we look at it and we see it. If you just take that intrinsic value per share and it converts to net asset value per share and you add a multiple to it, I think there's some significant upside in the portfolio that we have.

Okay. And what is the size of your total acquisition pipeline right now?

We would put that somewhere between $400 million and $600 million. The assets that we have, we have -- the one that we have under contract is approximately $21 million. The one under LOI is $26 million. We have a portfolio of 3 properties. We have another portfolio of -- but these aren't really portfolios, it's just the same seller, another one of 2 properties, and then we have 3 other properties, just those total there in excess of $300 million.

[Operator Instructions] And we'll take our follow-up question from Paul Adornato with BMO Capital.

On the relocation expense, I was wondering if you could just tell us a little bit more about the circumstances there. Has the home been sold? And when it is sold, is it possible that some of that will come back to the company?

Sure, Paul. I'd be glad to give a little more detail on the relocation expense that was recorded in the fourth quarter. I'll remind everyone that we, as any public company, have governance in effect. We have an independent Board of Trustees and an independent Compensation Committee. That Board and Compensation Committee, in July 2010, approved a relocation agreement for Mr. Mastandrea, and it has been fully disclosed in our SEC filings since that time. If you remember 6 years ago, Jim was asked to leave the company and relocated to Houston, and Whitestone's corporate offices, more than 5 years ago. And over those 5 years, Jim has had his house for sale. Pay has incurred security taxes, insurance, maintenance costs, and all of the headaches of owning a residence that's been located thousands of miles from where he is working. In December '12, Jim received an offer for the sale of his home after marketing the home for more than 5 years. The offer was from an unrelated third party and our Board felt it was the best interest of the company and our shareholders for Jim to go ahead and accept this offer and really bring closure to this situation that's been in place for many years. So the company does not own a house.

This does conclude our question-and-answer session. At this time, I would like to turn the conference back over to management for any additional or closing remarks.

I would just like to say thank you very much for, #1, your interest and your investment in Whitestone. We're excited about it. We've been excited, we've been at it here now for over 6 years, and it still continues to get our juices going each and every morning we get up. We've got a great team. We're still number -- its SKU is in the 60s, and it is really a business model that we think has a tremendous amount of future and opportunity, and building the infrastructure, we're finding new and better ways to add things to it each and every day, like the iPad system with a Square on in to [indiscernible] friends. So we're excited about it. We thank you. We invite any of you, if you like, to call us, or at anytime, and ask questions and even come to our investor meeting the next week. And with that, I'm going to say goodbye. Thank you, Dave, and thank you, Juanita.

Thank you. That does conclude our conference. You may now disconnect.